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Howard Marks put it nicely when he said that, instead of worrying about the volatility of share prices, ‘the possibility of permanent loss is the risk I worry about…and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when you check how risky it is, because debt is often involved when a business goes down. important, Tata Energy Company Limited (NSE:TATAPOWER) has debt. But should shareholders be concerned about using debt?
When debt is dangerous?
Debt helps a business until the business has trouble paying it off, either with new capital or with free cash flow. If things go really bad, the lender can take control of the business. However, the more common (but still painful) situation is that it has to raise new equity capital at a low price, thus permanently diluting the shareholders. Of course, debt can be an important tool in business, especially businesses with a lot of capital. When we think about the use of corporate debt, we first look at cash and debt together.
Check out our latest analysis for Tata Power
What is Tata Power’s net debt?
The image below, which you can click on for more details, shows that as of September 2022 Tata Power had ₹495.4b in debt, up from ₹455.1b a year earlier. On the other hand, it has cash of ₹82.5b leading to net debt of around ₹412.8b.
How strong is Tata Power’s balance sheet?
Zooming into the latest balance sheet data, we can see that Tata Power has ₹451.0b in trailing 12 month debt and ₹455.3b in overdue debt. Offsetting this, it has ₹82.5b in cash and ₹115.9b in receivables due within 12 months. As a result, its total liabilities are ₹707.8b more than the combined cash and short-term liabilities.
This deficit is quite relative to its market capitalization of ₹717.7b, so it is recommended that shareholders should monitor Tata Power’s debt utilization. If its lenders require it to depend on the balance sheet, shareholders may face severe dilution.
We measure a company’s debt load relative to profitability by looking at its net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA) and by calculating how well earnings before interest and taxes (EBIT) cover interest. Expenses (covering interest). The advantage of this method is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest costs related to that debt (with its interest coverage ratio).
A weak interest coverage of 1.1 times and a disturbingly high net debt to EBITDA ratio of 6.0 affects our confidence in Tata Power like a one-two punch to the gut. This means we will consider it heavily indebted. Another concern for investors may be that Tata Power’s EBIT fell by 16% last year. If things continue like this, debt management will be as easy as tying an angry house cat into its travel box. When analyzing debt levels, the balance sheet is an obvious place to start. But ultimately the future profitability of the business will decide whether Tata Power can strengthen its balance sheet over time. So if you want to see what the experts think, you might find this free report on analyst profit forecasts interesting.
Finally, businesses need free cash flow to pay off debt; Accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is supported by free cash flow. Looking at the last three years, Tata Power has recorded a free cash flow of 42% of its EBIT, which is weaker than we expected. That’s not a great thing, when it comes to paying off debt.
Our view
On the face of it, Tata Power’s net debt to EBITDA leaves us feeling bullish about the stock, and its interest coverage is no more attractive than an empty restaurant on the busiest night of the year. But at least the conversion of EBIT to free cash flow is not bad. It’s also worth noting that Tata Power is in the utilities industry, which is often considered relatively defensive. Overall, it seems to us that Tata Power’s balance sheet is quite vulnerable to business. Therefore, we are almost as wary of this stock as a hungry kitten is about to fall into its owner’s fish pond: once bitten, twice shy, as they say. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risk is on the balance sheet – far from it. Know that Tata Power is performing 2 warning signs in our investment analysis And 1 of them should not be ignored…
If you are interested in investing in a business that can grow profitably without the burden of debt, then check this out Free A list of growing businesses with net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methods and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any securities, and does not take into account your objectives, or your financial situation. We aim to bring you long-term focused analysis based on fundamental data. Please note that our analysis may not factor in company postings that are sensitive to the latest price or quality materials. Only Wall St has no position in any of the stocks mentioned.
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